Bank of Canada's Cote says financial risks persist

<p>The Bank of Canada building is pictured in Ottawa June 1, 2010. REUTERS/Chris Wattie</p>

TORONTO (Reuters) - International financial systems still face serious risks and Canada is not immune to vulnerabilities in market-based financing, a senior Bank of Canada official said on Tuesday.

“With the international financial system still facing serious risks, it is crucial that we maintain the momentum of reform,” Deputy Governor Agathe Cote said in prepared remarks to the Financial Markets Association of Canada.

Cote said the main sources of risks to Canada’s financial stability come from external factors, including stretched sovereign balance sheets in many advanced economies, large current account imbalances, and the continued struggle by foreign banks to strengthen their balance sheets.

“In the near term, the principal threat is that the acute fiscal strains in peripheral Europe could trigger a generalized retrenchment from risk-taking in global markets, including markets in Canada,” Cote said.

She said a long period of low interest rates globally may also fuel excessive risk-taking, noting the “search for yield” could cause risk to be underpriced or lead investors to take on exposures that they may not be able to manage if conditions become less benign.

“Since December, there has been mounting evidence of this search-for-yield dynamic in the global financial system, although the risk that it could lead to financial instability in Canada remains moderate,” Cote said.

Reiterating concerns laid out in the central bank’s December Financial Stability Board report, Cote said the main source of concern domestically continues to be the high level of debt carried by households, with the aggregate debt-to-income ratio of Canadians at a record high.

“This raises the risk that the impact of an adverse macroeconomic shock on the financial system could be exacerbated by a deterioration in the ability of households to service their debts,” Cote said.

Responding to an audience question about Canada’s hot housing market, which has helped drive household debt, Cote said recent government rule changes designed to cool the market should temper the pace of household debt growth.

“We think these measures are very helpful, they will certainly help in ensuring there is moderation in household credit going forwards,” Cote said.

Still, she noted it is taking “some time” to see the full effect of the new mortgage rules.

“Our view is that there should be some be moderation in household credit in the coming months and credit should be coming more in line with disposable income,” she said.

Canada’s housing boom worried the Canadian government enough to impose tighter mortgage rules, with latest changes aimed at mortgage amortization and refinancing coming into effect earlier this year.